Blogs & Comment

Beware of Greek democracy and black swans

Blink in this economy and a single black swan becomes a flock.

(Photo: Jozef Kotulic/Wikimedia)

Financial markets are currently gyrating over the unexpected announcement that the citizens of Greece—where democracy was born—will be allowed to vote on whether or not they will accept the future as it has been planned for them by European Union leaders, who are worried about bank failures in other nations, not focused on making life easier for the Greeks.

Prior to the announcement, of course, equity prices were riding a wave of optimism, albeit one fueled by low trading volumes because many investors simply have no idea about whether or not the euro zone will survive the risky loans that were so carelessly made to the EU’s so-called PIIGS (Portugal, Italy, Ireland, Greece and Spain).

The Greek referendum raises a lot of new questions (see biggest here). But well before Greek democracy tossed a monkey wrench into the political gears that were somehow supposed to reduce Greece debt to 120% of GDP by 2020, skeptics had good reason to doubt a real long-term solution to EU woes was actually in play.

Do the math. The year 2020 is more than eight years away. How anyone can expect smooth sailing between now and then for any country with serious book keeping issues is beyond me. Even if Greek creditors take a 50% haircut, and that somehow doesn’t get officially labeled a default on its financial obligations—which would cause an unknown amount of further market turmoil—you can bet that something nasty will happen that makes the wishful thinking that existed before the referendum announcement seem ridiculous.

In the summer of 2010, I attended a media roundtable for Canadian bankers, who, for whatever reason, wanted to hear what financial journalists thought about the sector’s growth prospects. Some panel members suggested the time was ripe for Canadian banks to aggressively take advantage of our industry’s reputation for stability because a global recovery was taking hold.

Not me. I told the room full of pinstripe suits to pat themselves on the back for being better than Lehman executives. Then I told them to hoist the corporate storm jib because I was pretty sure they would soon be facing another crisis.

At the time, I had no idea what type of crisis would hit next. I just knew a new crisis is always in the works. Here is a partial list of unexpected events since the Wall Street crash of 1987:

1993 Meltdown of Metallgesellschaft AG

1995 Collapse of Barings Bank

1997 Asian asset crisis

1998 Russian default

1998 Ukraine default

1998 Rescue of Long-Term Capital Management

2000 Dot-com crash

2000 Ukraine default 2.0

2000 Peru default

2001 9/11 terrorist attacks

2001 Argentina default

2001 Enron bankruptcy

2002 WorldCom bankruptcy

2003 Uruguay default

2005 Hurricane Katrina and Rita

2006 Implosion of Amaranth Advisors

2007 Subprime mortgage crisis in the United States

2007 ABCP fiasco in Canada

2008 Bankruptcy of Washington Mutual

2008 Lehman collapse

2008 AIG rescue 2009

2009 Chrysler bankruptcy

2009 General Motors failure

2010 Deepwater Horizon oil spill

2011 Greek debt market meltdown

2011 Middle East uprisings

2011 Japanese earthquake, tsunami and nuclear crisis

2011 U.S. debt downgrade

2011 Thailand flood

As you read this list, keep in mind that a lot of luck along with a lot of tax dollars has kept the world economy afloat in recent years. And there is a chance we are running out of both. Furthermore, many of the so-called non-events that markets have worried about since 1987, such as Y2K and flu pandemic threats, could have gone the other way.

In a commentary issued after the Japanese earthquake, Wall Street economist Robert Brusca noted the disaster was widely considered a once-in-a-thousand-year occurrence, or what market watchers call a black swan. But toss in everything else that has happened this year, and black swans appear to being flying in flocks these days. As things stand, today could very well prove to be a great time to buy stocks. But investing in equities at this point might just as easily be a huge mistake. Nobody really knows. And that’s why it is a good idea for retail investors to take optimism with a grain of salt.

When making up your mind on where to invest your life savings, remember March 2007. That was when U.S. central bank head Ben Bernanke told his political masters that troubles in the market for risky mortgages didn’t appear to be spreading, so “the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained.”

A month later, U.S. Treasury secretary Henry Paulson said the housing market correction appeared near its bottom and that troubles in the subprime mortgage market would likely not spread throughout the economy. “I don’t see (the subprime meltdown) imposing a serious problem. I think it’s going to be largely contained,” he added.

That was then. This is now. Blah. Blah. Blah. But some things, like the need to expect the unexpected, don’t change. In mid-2011, French-Belgian bank Dexia was rated one of the most stable in Europe after passing stress tests. Dexia, of course, recently failed and had its divisions nationalized.